What MNC’s are beginning to understand about doing business in Africa
Despite making marginally positive contributions to African economies, MNC’s have historically followed the trend of our colonial masters but are now beginning to feel the pinch…
Shortly following his inauguration in 2015, Nigeria’s President, Muhammadu Buhari, put in place some stringent measures against imported goods to spur domestic industries into manufacturing. Africa’s largest economy, Nigeria, with a gross GDP of over $400 billion[1] (International Monetary Fund, 2016), derives 95 per cent of export earnings and 70 per cent of government revenue from the oil sector[2]. In a world where oil prices are $30-60 per barrel Nigeria’s access to foreign exchange is severely limited. At the top of President Buhari’s agenda was to boost domestic manufacturing in order to curtail the country’s oil dependency.
With broad sweeping bold strokes, on June 23rd 2015, Buhari’s administration introduced a central bank policy that banned the use of foreign exchange for imports of 41 items[3] from rice and vegetables to soap and glass. Having worked in African private equity for the last four years, I have seen first hand the challenges facing Nigerian businesses as the ripple effect of this decision hit supply chains very hard. The heavy handed message from the CBN was effectively invest locally or get out! MNC’s have historically imported semi-finished and finished goods directly into African countries with minimal investment in Africa.
Why this is of concern to PZ Cussons
PZ Cussons, producer of detergents and soaps, has been operating in Africa since 1899. The company generates a third of its revenues and almost a quarter of its profits in Nigeria[4]. PZ Cussons also imports about 70% of its raw materials[5]. Fatty acids, derived from refining crude palm oil (CPO), are key inputs for the saponification process to produce soap noodles (the base product for bar soap). After forming PZ Wilmar in 2010 (a JV with Wilmar to refine CPO in Nigeria), PZ Cussons was effectively engaging in some local activities one step up the value chain. However, the reality was that most of the CPO was imported directly from Wilmar’s operations in Indonesia and Malaysia[6]. Following the CBN announcement, PZ Cussons, like many others was now in a place where it could not obtain dollars for its imports of palm oil products and had three alternatives before going out of business: (1) find substitute products to import – not really a viable option in this case (2) pay a significant premium for the limited dollars in short circulation on the parallel market (through bilateral deals with exporters) or (3) seek to further consolidate their supply chain locally.
What PZ Cussons has been doing about it
The company’s initial short-term strategy was to stock pile inventory whenever it obtained dollar liquidity for its Nigerian business before the supply of dollars shored up. However, in the medium term, PZ Cussons has no other choice but to double down on its backward integration strategy and develop thousands of hectares of oil palm plantation in Nigeria. However, quoting the FT article written by Chris Stein in November 2016, the challenge is Nigeria’s palm oil production is not currently enough to satisfy demand and it will probably take years.
Other steps PZ Cussons could take
PZ Cussons could attempt to use an out-grower scheme: guaranteeing offtake of palm oil from domestic suppliers should motivate them to increase yields. This could be coupled with leveraging Wilmar’s agri-expertise to educate local farmers. Furthermore, as it develops its own plantations, PZ Wilmar should engage firms like Indigo Agriculture to use their plant microbiome technology with hope of achieving radical efficiency gains in production yields. Finally, regardless of the whether the ban holds or not, I suggest PZ Cussons remains committed to further investing in Africa to consolidate its backward integration plan as this will provide much needed stability for the company for years to come.
Open questions
A few open questions remain as to how this will play out. Will protectionist policies in Nigeria be effective in building domestic supply chains? Will Nigeria’s infrastructure keep pace with required demands from domestic manufacturing? Will the production cost of a fully domestic value chain retain competitive pricing for Nigerians at attractive margins for PZ Cussons?
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Source of cover photo: “Investing in Nigeria Special Report,” Financial Times, November 14, 2017, https://www.ft.com/reports/investing-in-nigeria, accessed November 2017.
[1] International Monetary Fund, 2016. IMF Database. http://www.imf.org/external/datamapper/NGDPD@WEO/OEMDC/ADVEC/WEOWORLD/NGA
[2] Ministry of Budget and National Planning. (2014). Nigeria’s oil sector contribution to GDP lowest in OPEC – Blueprint. http://www.nationalplanning.gov.ng/index.php/news-media/news/news-summary/333-nigeria-s-oil-sector-contribution-to-gdp-lowest-in-opec-blueprint
[3] Central Bank of Nigeria. (June 23, 2015). Inclusion of some imported goods and services on the list of items not valid for foreign exchange in the Nigerian foreign exchange markets. https://www.cbn.gov.ng/Out/2015/TED/TED.FEM.FPC.GEN.01.011.pdf
[4] Lex Team, “PZ Cussons: navigating Nigeria,” Financial Times, January 27, 2015, https://www.ft.com/content/15cfbf48-a640-11e4-89e5-00144feab7de, accessed November 2017.
[5] Chris Stein, “Currency controls force Nigerian manufacturers to buy locally,” Financial Times, November 27, 2016, https://www.ft.com/content/160b19a4-8978-11e6-8cb7-e7ada1d123b1, accessed November 2017.
[6] Hadassah Egbedi, “PZ Wilmar Sinks 75m into Nigerian Vegetable Oil Plant,” Ventures Africa, February 18, 2015, http://venturesafrica.com/pz-wilmar-sinks-75m-into-nigerian-vegetable-oil-plant/, accessed November 2017.
Very interesting article that raises an important question, one that is not limited to Nigeria but relevant to several countries in Africa. In my opinion, protectionist measures will not suffice in driving local manufacturing and development of supply chain capabilities – at least this has been the case in Mozambique. I believe a much more organic approach needs to be taken. By simply limiting MNC’s in their ability to import finished goods does not in and of itself encourage creation of domestic companies to rival MNCs, which I believe is needed for long-term, sustainable economic development. More stringent regulations on MNCs means that they could choose to pull out from a country rather than stay and invest, especially if staying implies a strain on margins.
Nigeria and other African countries should not rely on MNCs to build out local supply chains but rather provide subsidies and other benefits to local companies to help them invest in manufacturing facilities and production processes. The Nigerian government should focus inward on fixing corruption as this would shore up funds to support local business. Nigeria scores very poorly on the Corruption Index with a score of 28 out of 100 (0 equals highly corrupt, 100 equals very clean), ranking it 136 out of 178 in the world (1). Prices for basic goods are far too high relative to the purchasing power because many goods are imported. Investment in local industry will in the long-term reduce prices for locals, and this is something the Nigerian government should prioritize for its citizens.
(1) https://www.transparency.org/country/NGA
While I agree the protectionist measures will not suffice in driving import substitution, it is the bold stroke that is required to move in that direction. Most of these MNCs have operated in Nigeria for decades but chose to continue dumping imported stuff into the country without showing any seriousness in local sourcing. They continue to report record profits in Nigeria which they repatriate abroad, but fail to make any investments in the country. The result – high youth unemployment! To buttress the point about the need for bold strokes, the Nigerian government had an import quota arrangement with Olam International (a leading agro commodities trader) to substitute local rice for imported rice over a period of 5 years, with several incentives promised. As investigation later revealed, Olam was able to access the incentives (not paying taxes for several years), but failed to implement the import substitution program.
Nestle is a role model for many MNCs in Nigeria. Nestle sources over 70% of its raw materials in Nigeria and was the least affected MNC by the import ban. Nestle is an example of a business that is building long-term, sustainable business in Nigeria. Most other MNCs are too short-sighted and seek to recover their investments too quickly. Africa, like any developing market is a long game. MNCs need to realise that.
The ban is working so far. Since its introduction, many MNCs have started making investments in local sourcing, something they always said was not feasible. The jury is still out whether government will stick to its guns on this, but it bode well for the economy in the long run if they are able to.
Corruption in Nigeria has nothing to do with this so I would not comment on that.
Your Nestle example is an interesting one. It made me think about whether you might need to institute a type of “cap and trade” system so that companies like PZ Cussons that rely heavily on raw materials that are not plentiful in Nigeria can avoid going out of business. The challenging thing for PZ Cussons is that even if they purchase palm oil domestically, it sounds like the total domestic supply is too low.
With a cap and trade system, the government could set a certain percentage of raw materials that need to be sourced locally (maybe this percentage increases over time). Companies like Nestle that are able to do this well, could sell their excess percentage points to PZ Cussons and then invest that money into continuing to build out operations and in Nigeria. It then buys companies like PZ Cussons time to make some of the longer term sourcing changes (and encourage the market to increase supply for raw materials needed).
Your questions about whether these measures will overload the Nigerian infrastructure, and whether local consumers will now be priced out, are important ones. The former is a longer-term concern, while the latter is something that the country will have to deal with almost immediately. It would be interesting to see the breakdown of Nigerian businesses that are today import-heavy and what their local switching costs are. The skeptic in me tells me that this plan will create strife in the short- and medium-term, and the risk is that the negative effects on the economy are so severe that the long-term benefits of this program are unable to pull the economy out of that hole. The government should consider subsidizing prices on any essential products whose prices are driven up as a result of this policy, to create a bridge measure that prevents short-term economic crisis.
There can be a differentiation between importing raw materials and importing finished goods. In the scenario described above, CBN has restricted all imports. However, there are some raw materials that either a) take time to be able to be fully supplied domestically (like CBO), or b) cannot be supplied domestically at all due to various limitations, natural or otherwise. I understand that being so heavily reliant on a single industry (oil production) for national GDP is risky, but concentrating the supply chain of a large business that also contributes to Nigeria’s GDP, leading to questions around its survival, is similarly risky. If the CBN is intent on implementing isolationist policies, they may be better done gradually, allowing for raw material imports in quantities that make sense for long term success of Nigerian companies and companies reliant on the Nigerian economy.
While I appreciate the intent of restricting imports to diversify Nigeria’s revenue, it seems it was done in two broad-sweeping a manner without taking into account the time requirements to grow those business in-country. The palm-oil example was a particularly striking example of this in that palm oil production will likely not meet demand, especially in the soap industry, for years – what does the population do in the meantime? Large scale corporations would have to subsidize the import of palm-oil to then manufacture soap within the country until farms could be brought up to scale. For MNC’s, their ability to easily pursue more lucrative opportunities elsewhere might discourage them from even staying in Nigeria at all.
Public policies to grant access of international organizations to Nigeria could be designed in a way to align incentives for both sides – local market development and expansion for the international organization. In situations in which there are no local companies to partner with, the government can provide a reliable environment to favor long-term investments that will have cascade benefits to the country, infrastructure and other capital-intensive sectors as examples.
One example is the Power Purchase Agreements (PPAs) for renewable energies in emerging markets. In Chile, for instance, several PPAs were priced in USD (not in local currency) for 15-20 years and renewable sources have priority in supplying to the national grid. In this scenario, international entities invested in capital-intensive assets in the country with a combination of international and local workforce, providing longer term benefits including technological development and cleaner energy supply.
Great article. Banning the use of foreign exchange as a mechanism for building its local manufacturing capability makes sense in theory; in order to become competitive on a global scale (and Nigeria was, at one time, one of the world’s largest producers of palm oil), there needs to be some sort of impetus to drive investment to the country. Such policies can successfully encourage needed investments in infrastructure and improved coordination between different players in the local economy.
A key risk here is that a holistic approach is not taken, as this sort of policy requires parallel development of local capabilities to promote local value creation and not have negative ripple effects across industries, as some commenters have alluded to above. Nonetheless, while there are certainly some short- and medium-term risks associated with taking such a ‘bold strokes’ approach to shifting Nigeria’s balance of trade, long-term benefits may still come Nigeria’s way by fostering demand for domestic goods and expanding its productive capacity.